Tax Considerations - Unit 21

If an investor swaps identical issues of stock to establish a loss that is disallowed, the transaction is known as A) a wash sale B) a reverse stock split C) a stock swap D) a stock cross

A) a wash sale The wash sale rule disallows claiming a tax loss on the sale of stock if the investor purchases a substantially identical security within 30 days either before or after the date of such sale.

A high net worth individual wishes to know when a gift can be made this year without being obligated to pay gift tax. You would respond that there is no gift tax when the gift is made to A) the American Red Cross. B) a non-citizen spouse. C) a grandchild of the donor. D) a sibling of the donor.

A) the American Red Cross Gifts to recognized 501(c)(3) charities, such as the American Red Cross, are never subject to the gift tax. If the spouse is a non-citizen, there is a limit ($152,000 in 2018) and anything in excess of $15,000 to a grandchild or sibling is taxable unless the donor elects to use the excess against the lifetime exclusion ($11.2 million in 2018).

The Wrights live in Texas, where Maria Wright has had an extremely successful cattle business for a number of years. As a very generous person, how much money can Maria give to her spouse, a Canadian citizen, in 2019 without incurring gift tax consequences? A) $100,000 B) A limited amount because her spouse is not a U.S. citizen C) $15,000 D) Unlimited

B) A limited amount because her spouse is not a U.S. citizen Under current tax regulations, there is a limit to the amount of a gift that may be made to a noncitizen spouse. For 2019, that limit is $155,000, (the amount is never tested).

Under current tax law (2019), how much can a married couple give to their adult son and his wife without incurring a gift tax obligation? A) $15,000 B) Unlimited C) $60,000 D) $30,000

C) $60,000 The current gift tax exclusion (2019) is $15,000 per donor to each recipient. A married couple can give $30,000 to a single individual and qualify for the exclusion. In this case, the married couple can give $30,000 to their son and $30,000 to their daughter-in-law without paying any gift tax.

Tax preference items are used for the purpose of computing the alternative minimum tax. They include all of the following except A) accelerated depreciation. B) certain incentive stock options. C) straight-line depreciation. D) excess intangible drilling costs.

C) straight-line depreciation Straight-line depreciation is not a preference item. All of the other choices are included in the IRS listing of tax preference items. In the case of the ISO, it is a preference item to the extent that the fair market value of the employer's stock is in excess of the strike price of the option. As a test-taking tip, when you see two opposites as answer choices, it is likely that one of them is the correct answer. In this case, we have straight-line and accelerated depreciation, only one of which is a preference item.

An individual purchased a variable life insurance policy 10 years ago with a guaranteed death benefit of $100,000. The annual premium for this policy was $2,000 per year. The individual dies and, due to outstanding performance of the separate account, leaves a death benefit to the beneficiary of $121,000. What are the income tax consequences to that beneficiary? A) There is a long-term capital gain of $1,000. B) Ordinary income tax is due on $21,000. C) Ordinary income tax is due on the $1,000 that exceeds the original cost. D) No tax is due.

D) No tax is due. One of the nice things about life insurance proceeds is that even when the death benefit is increased due to separate account performance, it is still free of income tax.

Using industry jargon, the tax on the last dollar of income is at A) the effective rate B) the final rate C) the average rate D) the marginal rate

D) the marginal rate The IRA defines marginal tax rate as "the highest rate that you will pay on your income." Basically, as you make more money, you pay tax at a higher rate incrementally. The effective tax rate is the average that you pay on all of your income.

A client owns a taxable bond with a coupon rate of 5%. His marginal tax rate is 28%. What is the after-tax yield he will receive on this investment? A) 6.94% B) 6.40% C) 1.40% D) 3.60%

D) 3.60% The client will earn an after-tax yield of 3.60%, or 5% × (1 − 0.28). Or, you could simply take off the 28% tax from 5% (1.40%) and subtract that from the 5% to arrive at 3.60%.

Grandma has decided to give her grandson some stock that she bought many years ago. When the grandson sells the stock, how is the tax liability figured? A) Both the cost basis and holding period are determined from the date of the gift. B) Her date of purchase is used, but the cost basis is from the date of the gift. C) Her cost basis is used, but the holding period begins on the date of the gift. D) Her cost basis and date of purchase is used.

D) Her cost basis and date of purchase is used. When stock is given as a gift, the donee (recipient) takes over the cost basis and the holding period of the donor.

Which of the following is (are) advantages of irrevocable insurance trusts? I. Provide estate liquidity. II. Insurance proceeds are removed from the estate of the insured for tax purposes. III. The insured has the flexibility to alter the trust arrangements. IV. Once set up, no changes may be made. A) II and IV B) I and III C) III and IV D) I and II

D) I and II As with all life insurance, the proceeds are available almost immediately upon death providing estate liquidity. When done properly, the proceeds of the policy are not included in the deceased's estate, thereby saving estate taxes. The trust is irrevocable—no changes can be made, and this is one of the few disadvantages.

Your client purchased 1,000 shares of ABC common stock on February 28, 2017. When would that purchase qualify for long-term capital gain or loss treatment? A) March 1, 2017 B) February 29, 2018 C) February 28, 2018 D) March 1, 2018

D) March 1, 2018 Long-term treatment applies when a sale is made more than 12 months after the purchase. The best way to compute this is to add 1 day to the purchase and then that same date, 12 months in the future. Adding one day to February 28, 2017 is March 1, 2017. Twelve months later is March 1, 2018.

Wade Kimmons purchased 200 shares of ABC common stock on March 9, 2009, paying $32 per share. Since the date of the purchase, Mr. Kimmons has received $518 in dividends. With the stock selling for $89 per share on July 27, 2016, Wade gives all 200 shares to his niece, Kendra. One week later, Kendra sells all of the ABC stock for $85 per share. The tax consequences of this are A) long-term capital loss of $800 B) short-term capital loss of $800 C) long-term capital gain of $11,118 D) long-term capital gain of $10,600

D) long-term capital gain of $10,600 When securities are the subject of a gift, the donee (recipient) acquires the donor's cost basis and holding period. That means that Kendra's cost was $32 per share and the holding period was over 7 years. That is a gain of $53 per share or a total of $10,600, and it is long term. The dividends have nothing to do with the question.

After receiving some money from an inheritance, an individual purchases a rare gold coin for $10,000. Five years later, he gives the coin to his daughter-in-law after receiving an appraisal showing the coin is worth $15,000. The daughter-in-law's cost basis of the coin is A) $0.00. B) $15,000. C) $10,000. D) $5,000.

A) $0.00 When a gift is made of an asset, whether it be a security or a collectible, the donor's cost basis passes to the donee. In this case, the original cost is $10,000 and that becomes the cost basis for the daughter-in-law and is used to determine a gain or loss when that coin is sold. Do not confuse this with the annual gift tax exclusion. Because the value of the gift did not exceed $15,000, the donor has no gift tax obligation, but that is completely different from the daughter's cost basis. U21LO5

Which of the following is federally tax exempt for a corporation? A) Preferred stock dividends B) Municipal bond interest C) Foreign corporate stock dividends D) Capital gains

B) Municipal bond interest Municipal bonds are tax exempt for corporations, as well as for individuals. Preferred stock dividends are taxable but at a reduced rate for corporations due to the 50% dividend exclusion. That break does not apply to the dividends on foreign securities. Regardless of the security, capital gains are taxable. U21LO6

Which of the following is an example of a regressive tax? A) Estate tax B) Gift tax C) Sales tax D) Income tax

C) Sales tax Regressive taxes are those where the rate remains the same, regardless of the cost of the item subject to the tax. For example, if your state has a 6% sales tax, it makes no difference if you are buying an item for $1.00 or one for $10,000, the tax rate is the same 6%. The other choices given are progressive taxes where the tax rate increases as the dollar amount being taxed increases.

A complex trust has the following income for the year: $1,500 in taxable interest, $2,000 in dividends (reinvested in the stock), and $3,000 in tax-exempt interest. In addition, the portfolio realized $3,500 in capital gains that were reinvested in the corpus. What is the distributable net income (DNI) for the trust? A) $6,500 B) $1,500 C) $4,500 D) $10,000

A) $6,500 All investment income, regardless of source, will be considered DNI and will be included in the taxable income calculation to the trust unless distributed. That portion of the DNI representing tax-exempt interest maintains its tax-free status. Reinvested capital gains are not part of a trust's DNI. The computation is: $1,500 in taxable interest + $2,000 in dividends (reinvestment means nothing here) + $3,000 in tax-exempt interest. This is a total of $6,500 of DNI. When distributed, only $3,500 will be taxable.

If a husband makes a gift of $100,000 to his wife, a U.S. citizen, how much of the gift is subject to gift taxes? A) $50,000.00 B) $100,000.00 C) $90,000.00 D) $0.00

D) $0.00 Interspousal gifts to citizens of the United States, regardless of amount, are not subject to gift taxes.

Mr. Wright died with the following assets and liabilities: $200,000 in securities left to his wife, a $650,000 home left to his wife (the home cost $150,000), a $250,000 life insurance policy with his daughter as beneficiary, and $75,000 in debts and estate expenses. What is Mr. Wright's gross estate? A) $600,000.00 B) $1,025,000.00 C) $250,000.00 D) $1,100,000.00

D) $1,100,000.00 The question asks for the gross estate, not the adjusted gross estate or taxable estate. The market value of all assets in which Mr. Wright possessed an incident of ownership at the time of death are included in the gross estate. The amount is therefore $1,100,000. The adjusted gross estate would be less the $75,000 of debt and expenses.

Regarding the treatment of estates by the IRS, it would not be correct to state any of the following EXCEPT A) a deceased person may reduce the value of the estate by taking advantage of the annual gift tax exclusion B) estates may be valued either at date of death or 9 months later using the alternative valuation option C) the maximum tax rate on estates is the same as that on gifts D) income received by the estate is reported on Form 1040

C) the maximum tax rate on estates is the same as that on gifts The maximum tax rate on estates and gifts is 40% (the number is not tested; only that the rates are the same). The alternative valuation date is 6 months after death; 9 months after death is when the tax is due. Dead people can't make gifts and any income received by the estate before it is liquidated is reported on Form 1041.

One of your ultra-high net worth clients would like to give some low cost basis stock as gifts to her adult grandchildren. It would be prudent for you to tell her that A) making the gift under the Uniform Transfer to Minors Act is generally the most advantageous for the child. B) unlike an inheritance, there is no stepped-up cost basis. C) for purposes of the gift tax, her cost basis will be used. D) it would be wise for her to use a TOD account to avoid probate.

B) unlike an inheritance, there is no stepped-up cost basis One of the benefits of inheriting low cost basis securities is the stepped-up basis and that does not apply to gifts. Although the donor will not be the one subject to capital gains tax, it would be the right thing to do to let her know that the donees (her grandchildren) will be receiving the stock at her cost basis. TOD would not apply to stock that is the subject of a gift; it is only when the stock remains in the grandmother's name and has been designated for the grandchildren after her death. When computing the value of a gift to determine if there is a gift tax obligation, it is the fair market value of the gift that is used. Finally, the question states these are adult grandchildren - UTMA would not apply to them.

A customer buys 100 XYZ at $30. Two years later, with the stock trading at $70, the customer makes a gift of the securities to his son. Which of the following statements are TRUE? I. For gift-tax purposes, the value of the gift is $3,000. II. For gift-tax purposes, the value of the gift is $7,000. III. The son's cost basis on the stock is $3,000. IV. The son's cost basis on the stock is $7,000. A) II and III B) I and IV C) I and III D) II and IV

A) II and III When making a gift of securities, the market value at date of gift is used to determine if any gift taxes are due. However, when making a noncharitable gift of securities, the donor's cost basis is passed to the recipient.

Which of the following business entities has an income tax filing due date (disregarding possible extensions) of March 15? 1. Sole proprietorship II. Single-member LLC III. Multiple-member LLC electing to be treated as a corporation​ IV. S corporation A) III and IV B) I and IV C) I and II D) II, III, and IV

A) III and IV For partnership returns (including LLCs with more than 1 member) and S corporation returns, the due date is March 15. One effect of this is that LLCs, partnerships, and S corporations all have the same filing deadline. For C corporations, the due date is the 15th day of the 4th month following the close of the corporation's year; this date is April 15 for a calendar-year filer.

XYZ, Inc. is a C corporation in the 21% federal income tax bracket. Which of the following investments offers the company the highest after-tax return? A) Municipal bond with a 5% coupon rate B) REIT paying a 6.5% dividend C) Corporate bond with a 6.75% coupon D) ABCD, Inc. preferred stock paying a 6% dividend

D) ABCD, Inc. preferred stock paying a 6% dividend The key to this answer is that corporations have a 50% dividend exclusion on dividends received from other companies. The math looks like this: Only half of the 6% dividend is taxable. That means 3% per year is tax free and the other 3% is subject to tax at the 21% rate. So, we have 3% + 79% of the taxable 3% = 3% + 2.37% = 5.37% after-tax return. The municipal bond is not taxed, but that only produces 5% after tax. The corporate bond is subject to 21% tax so the corporation gets to retain the other 79%. That computes to 6.75 x 79% = 5.33%, just a bit less than the preferred stock. In most cases, dividends paid to corporations by REITs are fully taxable. That makes the after-tax return on the 6.5% dividend only 5.14%. U21LO6

Investors looking to minimize the effects of taxation on their investments would probably receive the least benefit from A) an S&P 500 index fund B) an apartment building C) a growth stock D) a corporate bond

D) a corporate bond Investors receive interest income from corporate bonds. That income is fully taxable at ordinary income rates. Real estate ownership has certain tax benefits, such as depreciation and a deduction for operating expenses. Index funds are known for their high tax efficiency and investors in growth stocks anticipate long-term capital gains which are taxed at a lower rate than ordinary income.